What a home equity line of credit costs, and how to compare two offers

The rate is only one part of what a home equity line of credit, or HELOC, costs. Fees at the start, fees every year and fees at the end all add to the total. This guide breaks the cost into its parts and shows a way to compare two offers line by line.

Key takeaways

A HELOC's cost is the interest you pay plus every fee, not the rate alone.
A variable rate is an index plus a margin, and the margin is the part each lender sets.
Some fees are charged once, some every year, and some only if you close the line early.
Two offers compare fairly only when you price them on the same balance over the same years.

The cost has three layers

Think of the cost of a HELOC in three layers. The first is interest on the money you have drawn. The second is the set of fees you pay to open the line and keep it. The third is what you may owe if you close it sooner than the lender expects.

A lender's advertisement usually shows only the first layer. A fair comparison needs all three, because a line with a lower rate can still cost more once the fees are added.

How the rate is built

Most HELOCs carry a variable rate. It has two pieces: an index and a margin. The index is a published benchmark rate that moves with the wider lending market. The margin is a fixed number of percentage points the lender adds on top.

The index changes over time, and your rate follows it.
The margin is the part you can compare. Two lenders using the same index differ in ongoing rate only by their margins.
The cap is the highest rate the agreement allows. Ask for it in writing.

An introductory rate is a lower starting figure that applies for a short period. When it ends, the rate becomes the index plus the margin, so compare lenders by margin and not by the starting figure.

How interest is charged

You pay interest only on the balance you have drawn, not on the whole limit. If you draw nothing, you owe no interest, though a yearly fee may still apply.

Interest is figured on the balance each day or each month, depending on the lender. A balance that sits for a full year costs a full year of interest, so the length of time you carry a balance matters as much as the rate.

The fees that can appear

Fees fall into three groups, and a lender may charge from any of them.

At the start

An appraisal, which is a professional estimate of your home's value.
An application or origination fee for processing the line.
Closing costs such as title search, title insurance and recording fees.

While the line is open

An annual fee, sometimes charged even when the balance is zero.
A fee each time you draw, or a minimum amount you must draw.
An inactivity fee if you do not use the line.

At the end

An early closure fee if you close the line within the first few years.
A repayment of any closing costs the lender waived at the start.

When costs are waived

Some lenders say they will cover your closing costs. Read what that means. Often the lender pays them up front and expects you to repay them if you close the line within a set period, commonly the first two or three years.

A waiver can be a good deal if you plan to keep the line open. It is a poor one if you expect to close it soon. The question to ask is simple: what exactly do I owe, and when, if I close this line early?

Comparing two offers line by line

Put the offers in two columns and fill in the same rows for each: the index, the margin, the cap, every fee at the start, every yearly fee, and the early closure terms. Then price both offers on the same balance for the same number of years.

Example with round numbers. Suppose you expect to carry an average balance of $20,000 for five years.

Line A has a margin of 2.00 points, no yearly fee and no closing costs. Line B has a margin of 1.50 points, a $75 yearly fee and $600 in closing costs.

Half a point on $20,000 is $100 a year in interest. Line B's yearly fee is $75, so the interest difference nets down to $25 a year, or $125 over five years. That does not cover $600 in closing costs, so on these numbers Line A costs less overall.

The figures are made up to show the method. They are an illustration, not an offer from any lender, and real offers will differ.

Change the balance or the number of years and the answer can flip. A larger balance rewards a lower margin. A short stay rewards low fees.

Before you decide

Ask each lender for a written list of every fee, with the amount and the date it is charged.
Ask what the line costs per year if you borrow nothing.
Ask whether any fee can change after you open the line.
Read the sample payment tables in the disclosure, and check them against the cap.

Once a line on your main home is open, federal law generally allows a short cancellation window of three business days. Use that time to read the paperwork once more against your comparison sheet.

About this guide. This guide explains how HELOCs work in general terms. It doesn't recommend any contractor or product, and nothing in it is a quote or an offer. Costs, rules and timelines vary by home and by area.